Depreciation of Real Estate Property: Should You Tap Into the Multi-Million Naira Short Let Real Estate Market? | PlistHub 2023
Depreciation of real estate property is a key tax-saving strategy.
According to the IRS, depreciation is the process of recovering an asset’s acquisition cost up until the asset is recovered. The process uses an asset that depreciates annually, such as a building. The depreciation value is determined by multiplying the property’s acquisition cost by the relevant rate. Every year, this sum is subtracted. No actual financial flow is engaged in the depreciation accounting.
It merely accounts for any wear and tears during an asset’s useful life to reflect its present worth. Since the account is just documented in the account books, no actual financial movement is involved. Depreciation helps reduce one’s tax burden for property income since the depreciation value can be subtracted from the earnings.
How is depreciation of real estate property determined?
The IRS has established a method for computing depreciation. Investors can learn how much they can depreciate each year through this procedure. The steps involved are as follows:
- Figure out if you qualify for depreciation. There are numerous important requirements. Some of these are that the investor must own the property, naturally depreciate, and be used for income-generating activities like leasing.
- Calculate the acquisition cost’s basis. It covers installation expenses, freight fees, and other costs. Expenses for any land that was part of the building must be subtracted. To account for any expenses or income on the property until it is ready for rental, make any additions or subtraction from this figure.
Investors must then decide on the best depreciation technique. The Modified Accelerated Cost Recovery System, for instance.
The General Depreciation System (GDS) and Alternative Depreciation System (ADS) are the two methodologies that the IRS has designated (ADS).
Yes, depreciation of real estate property may seem like a surefire way to lower real estate investors’ taxes. But, it is crucial to remember that the IRS has extremely specific and complicated criteria about how depreciation can be used as a tax deduction. Owners of rental properties may have inquiries about how those regulations operate and how they apply to their particular position regarding investments.
Due to the low yield associated with the prevalent annual rent policy, most investors were reluctant to participate in real estate for a long time. In the Nigerian rent chronology, this practice dates back to the early 1990s and has developed into a long-standing custom.
Thoughts that seemed forgotten throughout those years of long-term monthly and yearly rental practice have been revived due to some property professionals’ embrace of the short-term rental market. The realization was that the usual long-term real estate market pattern is less profitable than short-term property leasing. Most land brokers were against this paradigm shift, and several real estate experts described it as a “risky engagement.” But what precisely is the real estate market for short-term rentals? Is it successful?
Nigeria’s Real Estate Sector Is Highly Lucrative
The greatest real estate market in Africa is in Nigeria, the renowned “Giant of Africa.”
Over $523 million has been invested in the real estate sector. The value of ROI is still less than 3% nationwide, despite how promising these data seem. The rising risk in the sector is reflected in this number.
Generally, real estate is attractive and profitable, despite the hazards. Experts estimate that property investors have a fair probability of recovering about 17% of their initial investment. The lowest predicted income is around 15%, which can go to 20%.
Real estate and Naira Depreciation
Most property business people’s net income has been hurt by the Nigerian Naira’s current FX loss to the US Dollar. However, this unfavorable trend has both advantages and disadvantages. Positively, the value will not be impacted over time if the property is kept in good condition, making the profit somewhat illiquid.
Despite rising inflation and Naira’s depreciation against the US dollar, real estate professionals believe this is the ideal time to invest in Lagos’ real estate market.
Their recommendations are based on the increasing land values and property prices throughout the Lagos market, particularly in the surrounding areas of Lekki-Epe and the Lekki Free Trade Zone (LFTZ).
Meanwhile, they pointed out that investors in this corridor are finding real estate to be an increasingly alluring asset class to hedge against inflation and earn respectable rates as a result of the rising inflation.
They claim that due to this appeal, investments in real estate, particularly residential real estate, have increased.
According to research by the Nigerian Tribune, numerous developers in the axis have started revising the pricing of their plots in the neighborhood upward due to the rise in land values in the Lekki FTZ and surroundings.
On the other hand, most real estate investors are concerned by naira depreciation because it is one of the main reasons for-profit fragility and can lead to losses. Investors are typically in a profit-neutral zone since the percentage increase in profits typically equates to Naira’s depreciation.
The real estate market has struggled to expand due to these unfavorable conditions, but the emergence of the property short-let movement has heralded the dawn of a new age in the industry.
Consequently, tax savings of hundreds to thousands of dollars per year are possible for real estate investors, thanks to write-offs from depreciation. A real estate investment’s cost can recover tax deduction known as real estate depreciation. Depreciation is recognized as a deduction of some kind, lowering the investor’s taxable income.
The cost of purchasing and making improvements to a rental property is deducted through depreciation throughout the property’s useful life, as opposed to rental expenses, which include items like repair and maintenance costs, travel costs related to property management, home office expenses, property taxes, mortgage insurance, property insurance, and professional services.
Home Depreciation: Is Your Property Eligible for Depreciation?
Investors should first be aware of the types of rental properties that the IRS allows for depreciation. Property only qualifies as depreciable if it is owned by the investor (even if they have debt on it), used in their business or to generate money, has a “useful life” (i.e., deteriorates with time), and this useful life is anticipated to last longer than a year.
The asset cannot be used and disposed of in the same year to qualify for depreciation. Landowners cannot deduct charges for clearing, planting, landscaping, or depreciation on the land.
Even if the item has been sold or traded, converted to personal use, abandoned, or destroyed, the owner may still deduct depreciation until the whole cost or basis in the asset has been subtracted or until the equipment is deemed to have been “retired from service.” Additionally, as long as at least one repair has been completed to prepare for the new tenant, deduction claims can be made on a property that is momentarily not in use, such as the time between one tenant moving out and another renter moving in.
Tax Deductions for Home Depreciation
Depending on the investor’s tax bracket, the tax liability will be lowered. That percentage will determine the deduction’s size.
Investors can benefit from depreciation by spreading out the cost of a property’s purchase over several years and claiming deductions for each. It is more of a way to make up for lost investments than a method for increasing wealth.
Working with a knowledgeable tax accountant when calculating depreciation is advisable to avoid accidentally breaking the laws and undervaluing this crucial investment tool because the IRS does occasionally update the depreciation regulations.
Short-let Bubble: The Depreciation of Real Estate Property
Landowners place tenants daily in the short-term rental market, a contemporary renting pattern. Due to its profitability and bright future, it was founded by Shortlethomes and has since been embraced by numerous real estate companies. The average yield linked with a long-term rental agreement is one of the many aspects that contribute to the market’s expanding fame.
However, this short-term rental agreement has a few exclusions and restrictions. As things stand, the Naira value depreciation rate is 15%, and accommodating at least 50% of residents is the only way to significantly increase your short-term rental income. International investors are also unlikely to see a return on their investments in the neighborhood.
As the primary cause of income decline in short-term rentals, the price of construction materials also has a substantial impact. However, a 40 percent yield can be achieved and sustained with short-term rental property, as opposed to the 15 to 20 percent yield in the long-term rental market.
Taking advantage of the short-let rental market worth millions of Naira
Despite the high cost of construction materials associated with the short-term rental market, the money made over a brief period justifies the expenditure. Thanks to effective management, several real estate professionals have generated millions of Naira in rental revenue and quickly recouped their initial investment.
However, a minimum occupancy rate should achieve 50% because anything below this level will probably not produce decent dividends. Effective management, marketing that works, and quality control are key components in achieving these objectives.
How Short Let Market Thrives?
The thriving rental industry now includes the competitive lodging service of short-term renting of real estate. It competes with lodging establishments like hotels, motels, and guesthouses, among others, and its rules are often reasonable.
The absence of regulations in renting lodging facilities like hotels is a clear sign that it is not yet safe and will most likely stay that way. Additionally, some people choose hotels for temporary housing since they are unaware of the tendency.
Most short-term players have developed strategies to increase revenue to obtain a competitive edge and increase awareness. These include events like show evenings, party villas, baby showers, wedding receptions, kid dedications, spa days, bridal showers, birthdays, and other art-related celebrations. Such events can produce additional money to millions of Naira in addition to the short-term benefits from everyday profits. This is because Nigeria currently has one of the world’s most lucrative and viable recreational markets.
Organizing a short-term rental property business
Like any other business, short-term rentals require funding. The size of the structure and the cost of the building materials on the market will determine the amount of money needed.
Real estate investors will make more money if they select huge, luxurious flats instead of medium-sized structures with basic appliances. Another crucial element that affects its profitability is the location. Investments in short-term rentals in metropolitan and downtown regions will provide greater returns than those in rural and suburban locations.
Investors benefit financially from the alternatives for renting, leasing, and purchasing in the short-term rental market. Events indicate that this lucrative multi-billion dollar market will soon be on par with lodgings, motels, hotels, etc., due to its growing popularity and rapid expansion. The catch is that you must reach an occupancy rate of at least 50% to generate millions in this market, which some short-term investors have added to the game.